New York Law Review

Tag: accountant liability

  • Securities Investor Protection Corp. v. BDO Seidman, 95 N.Y.2d 702 (2000): Accountant Liability to Non-Privy Third Parties

    Securities Investor Protection Corp. v. BDO Seidman, 95 N.Y.2d 702 (2000)

    An accountant’s liability for negligent misrepresentation to a non-privy third party requires a relationship approaching privity, established by awareness of a specific purpose for the reports, knowledge of intended reliance by a known party, and linking conduct demonstrating understanding of that reliance.

    Summary

    The Securities Investor Protection Corporation (SIPC) sued BDO Seidman (BDO), an accounting firm, alleging negligent and fraudulent misrepresentation regarding audits of A.R. Baron & Co., a brokerage firm. SIPC claimed BDO’s misrepresentations led to delayed intervention, increasing liquidation costs. The New York Court of Appeals held that SIPC could not recover against BDO for either fraudulent or negligent misrepresentation because SIPC did not directly rely on BDO’s statements, and there was no relationship approaching privity between SIPC and BDO. The regulatory framework, including the NASD’s intermediary role, broke the causal chain.

    Facts

    A.R. Baron & Co., a brokerage firm, hired BDO to audit its financial statements, as required by SEC rules. BDO issued annual audit reports to the NASD, the designated self-regulatory organization. Baron’s management engaged in fraudulent activities, concealing debt and manipulating stock values. BDO’s audit reports initially showed a healthy debt-to-capital ratio for Baron. SIPC alleges that BDO’s failure to properly audit Baron delayed SIPC’s intervention, leading to increased costs for settling customer claims after Baron’s bankruptcy.

    Procedural History

    SIPC and the trustee for Baron’s liquidation sued BDO in the United States District Court for the Southern District of New York. The District Court dismissed SIPC’s claims. The Second Circuit Court of Appeals affirmed the dismissal of claims on behalf of Baron’s customers but allowed SIPC to sue on its own behalf. The Second Circuit certified two questions of New York law to the New York Court of Appeals regarding accountant liability to third parties.

    Issue(s)

    1. May a plaintiff recover against an accountant for fraudulent misrepresentations made to a third party where the third party did not communicate those misrepresentations to the plaintiff, but where defendant knew that the third party was required to communicate any negative information to the plaintiff and the plaintiff relied to his detriment on the absence of any such communication?
    2. May a plaintiff recover against an accountant for negligent misrepresentation where the plaintiff had only minimal direct contact with the accountant, but where the transmittal to the plaintiff of any negative information the accountant reported was the “end and aim” of the accountant’s performance?

    Holding

    1. No, because the plaintiff cannot claim reliance on misrepresentations of which it was unaware, even by implication.
    2. No, because there was no “linking conduct” that put SIPC and BDO in a relationship approaching privity.

    Court’s Reasoning

    The Court reasoned that for fraudulent misrepresentation, the misrepresentation must form the basis of the plaintiff’s reliance. SIPC relied on the NASD’s silence, not BDO’s representations. The court distinguished this case from Tindle v. Birkett, where the plaintiff received a positive credit report. Here, SIPC was unaware of any of BDO’s alleged misrepresentations. The court emphasized the NASD’s evaluative role, stating that the absence of communication from the NASD to SIPC could mean various things, not just a clean bill of health. The court stated, “The regulatory framework involved in this case thus creates an insurmountable disconnect between EDO’s representations and SIPC’s purported reliance on those representations.”

    For negligent misrepresentation, the Court applied the Credit Alliance test, requiring awareness of a specific purpose, knowledge of intended reliance by a known party, and linking conduct demonstrating understanding of that reliance. Here, there was no “linking conduct” creating a relationship approaching privity between SIPC and BDO. BDO’s audits were not prepared for SIPC’s specific benefit and were not sent to or read by SIPC. The Court reaffirmed the necessity of demonstrating a relationship approaching privity, clarifying that “end and aim” is not the sole determinant. The absence of direct contact and a clear link between BDO’s actions and SIPC’s reliance precluded a finding of negligent misrepresentation.

  • Parrott v. Coopers & Lybrand, 95 N.Y.2d 479 (2000): Accountant Liability to Third Parties Absent Privity

    95 N.Y.2d 479 (2000)

    Before a party can recover in tort for pecuniary loss from negligent misrepresentation, there must be either actual privity of contract or a relationship so close as to approach privity, requiring awareness of use for a particular purpose, reliance by a known party, and conduct linking the maker of the statement to the relying party.

    Summary

    Harold Parrott, a former employee of Pasadena Capital Corporation, sued Coopers & Lybrand (C&L) for professional negligence and negligent misrepresentation after C&L’s valuation of Pasadena’s stock, used to repurchase Parrott’s shares upon termination, was significantly lower than an independent valuation determined in arbitration. The New York Court of Appeals affirmed the dismissal of Parrott’s claim, holding that Parrott failed to establish a relationship with C&L approaching privity. The court emphasized that C&L was unaware its valuation would be used specifically for Parrott’s stock repurchase agreement and there was insufficient evidence of direct contact or reliance to create a near-privity relationship.

    Facts

    Harold Parrott purchased shares of Pasadena Capital Corporation stock per a 1992 agreement stating that upon termination, Pasadena would repurchase the stock at fair market value determined by a third-party appraisal for its ESOP. C&L provided biannual valuation reports for Pasadena’s ESOP. Parrott was terminated in May 1996. In September 1996, Pasadena, relying on C&L’s June 30, 1996 valuation of $78.21 per share, exercised its right to repurchase Parrott’s stock. Parrott challenged this valuation, and an arbitrator later determined the value to be $122.50 per share. Parrott then sued C&L.

    Procedural History

    Parrott sued C&L in Supreme Court, which denied C&L’s motion for summary judgment. The Appellate Division reversed, granting summary judgment to C&L and dismissing the complaint. The New York Court of Appeals affirmed the Appellate Division’s decision.

    Issue(s)

    Whether Parrott established a relationship with C&L so close as to approach privity, such that C&L owed him a duty of care in preparing its valuation report.

    Holding

    No, because Parrott failed to demonstrate that C&L was aware that its valuation reports would be used for the specific purpose of determining the repurchase price of Parrott’s stock under his individual stock purchase agreement, and because there was no direct contact or conduct linking C&L to Parrott demonstrating C&L’s understanding of his reliance.

    Court’s Reasoning

    The court reiterated the Credit Alliance tripartite test for establishing a relationship equivalent to privity in negligent misrepresentation cases: (1) awareness by the maker of the statement that it is to be used for a particular purpose; (2) reliance by a known party on the statement in furtherance of that purpose; and (3) some conduct by the maker of the statement linking it to the relying party and evincing its understanding of that reliance. The court found that Parrott failed to satisfy these criteria. C&L’s awareness was limited to providing biannual valuations for Pasadena’s ESOPs generally, with no indication that C&L knew the reports would be used in connection with Parrott’s stock purchase agreement. Parrott also did not rely on the reports, as he never read them and immediately challenged the valuation. Finally, the court found no conduct directly linking Parrott and C&L demonstrating C&L’s understanding of any reliance on Parrott’s part. The court quoted Prudential Ins. Co. v Dewey, Ballantine, Bushby, Palmer & Wood, 80 NY2d 377, 382, stating the need to provide “fair and manageable bounds to what otherwise could prove to be limitless liability”. The court distinguished White v. Guarente, 43 NY2d 356, where the accountant’s services were specifically obtained to benefit the members of a limited partnership. The court also rejected a rule permitting recovery by any ‘foreseeable’ plaintiff, quoting Ossining Union Free School Dist. v Anderson LaRocca Anderson, 73 NY2d 417, 425, that such a rule would be overly broad.

  • William Iselin & Co. v. Mann Judd Landau, 71 N.Y.2d 420 (1988): Accountant Liability to Non-Contractual Parties

    71 N.Y.2d 420 (1988)

    An accountant may be held liable to a non-contractual party for negligence in preparing financial reports only if the accountant was aware the reports were to be used for a specific purpose, a known party was intended to rely on them, and there was conduct linking the accountant to that party demonstrating the accountant’s understanding of their reliance.

    Summary

    William Iselin & Co., a factoring company, sued Mann Judd Landau, an accounting firm, for negligence in preparing review reports for Suits Galore, a clothing manufacturer. Iselin claimed it relied on these reports in extending credit to Suits, which later went bankrupt. The New York Court of Appeals affirmed the dismissal of Iselin’s claim, holding that Iselin failed to demonstrate a relationship with Mann that sufficiently approached privity, as required by Credit Alliance Corp. v. Andersen & Co., to impose liability for negligent misrepresentation to a third party. The court emphasized that a review report is different from a certified audit and that Iselin did not provide sufficient evidence to show that Mann knew Iselin specifically intended to rely on the reports.

    Facts

    William Iselin & Co. acted as a factor for Suits Galore, providing secured loans and purchasing accounts receivable. Iselin also extended unsecured “overadvances” to Suits, which were typically repaid within the same year. Mann Judd Landau was engaged by Suits to review and report on its financial statements. Iselin came into possession of Mann’s Review Report for the fiscal year ending May 31, 1982, and subsequently increased Suits’ overadvance line. By June 1983, the overadvances reached $3.4 million. Mann issued its Review Report for the fiscal year ending May 31, 1983. After receiving the report, Iselin demanded that Suits reduce the overadvance level. In December 1983, Suits filed for bankruptcy, leaving much of its debt to Iselin unpaid.

    Procedural History

    Iselin sued Mann for negligence, gross negligence, and fraud. The Supreme Court dismissed the gross negligence and fraud claims but denied summary judgment on the negligence claim. The Appellate Division reversed, granting summary judgment to Mann, finding that Iselin failed to satisfy the privity test from Credit Alliance Corp. v. Andersen & Co. The New York Court of Appeals granted leave to appeal and affirmed the Appellate Division’s decision.

    Issue(s)

    Whether Mann Judd Landau, an accounting firm, could be held liable to William Iselin & Co., a non-contractual third party, for negligence in the preparation of review reports, absent a relationship sufficiently approaching privity.

    Holding

    No, because Iselin failed to demonstrate a relationship with Mann that sufficiently approached privity. Iselin did not provide sufficient evidence showing that Mann was aware that the review reports were specifically prepared for the purpose of inducing Iselin to extend credit to Suits or that Mann understood Iselin’s reliance on the reports.

    Court’s Reasoning

    The court relied on the precedent set in Credit Alliance Corp. v. Andersen & Co., which established a three-part test for accountant liability to non-contractual parties: (1) the accountants must have been aware that the financial reports were to be used for a particular purpose; (2) a known party was intended to rely on the reports; and (3) there must have been conduct linking the accountants to that party, demonstrating the accountants’ understanding of that party’s reliance. The court found that Iselin failed to provide sufficient evidence to satisfy this test. The engagement letter between Mann and Suits, while mentioning credit inquiries, did not establish that the review reports were specifically prepared for Iselin’s benefit or that Mann knew Iselin would rely on them. The court emphasized the importance of a nexus between the parties, stating, “[T]he noncontractual party must demonstrate a relationship with the accountants ‘sufficiently approaching privity’”. The court also noted that a review report offers limited assurance compared to a certified audit. Iselin’s submission lacked admissible evidence showing a link between the parties demonstrating Mann’s understanding of Iselin’s reliance. A conclusory assertion by Iselin’s president was deemed insufficient, and even if a review report was sent to Iselin at Suits’ request, it would not satisfy the requirement of demonstrating Mann’s understanding of Iselin’s reliance. The court concluded that no material issue of fact requiring a trial was presented.

  • Westpac Banking Corp. v. Seidman & Seidman, 67 N.Y.2d 62 (1986): Accountants’ Liability to Third Parties Absent Privity

    Westpac Banking Corp. v. Seidman & Seidman, 67 N.Y.2d 62 (1986)

    Accountants are not liable to non-contractual parties for negligently prepared financial reports unless the accountants were aware that the reports were to be used for a particular purpose, a known party was intended to rely on the reports for that purpose, and there was conduct by the accountants linking them to that party evincing the accountants’ understanding of that party’s reliance.

    Summary

    Westpac Banking Corp. sued Seidman & Seidman, alleging negligence in the preparation of financial statements for Turnkey Equipment Leasing, Inc. (TEL). Westpac claimed it relied on these statements when providing a bridge loan to TEL. The New York Court of Appeals held that Seidman was not liable to Westpac because Westpac was merely a potential lender, not a known party, and there was insufficient evidence linking Seidman directly to Westpac’s reliance. The court emphasized the need for near-privity between the accountant and the relying party to establish liability in the absence of a direct contractual relationship. The potential for liability under federal securities laws did not expand the accountant’s common-law duty.

    Facts

    Turnkey, seeking a public offering, retained Seidman to audit its financial statements. Westpac extended a $2 million line of credit to Turnkey. Turnkey also sought a bridge loan to be repaid from the proceeds of the public offering. Westpac reviewed the certified financial statements prepared by Seidman and agreed to provide a $2 million bridge loan. Seidman later withdrew its certification when Turnkey’s fraud surfaced, and the public offering was abandoned. Westpac sought to recover its losses from Seidman, alleging negligence in the audit and report.

    Procedural History

    The trial court dismissed Westpac’s negligence claim but the appellate division reversed, reinstating the claim. The Court of Appeals then reversed the appellate division’s order, dismissing the negligence claim, citing its recent decision in Credit Alliance Corp. v. Andersen & Co.

    Issue(s)

    Whether an accountant owes a duty of care to a specific lender, where the accountant knew the financial statements would be used to obtain a bridge loan but did not know the identity of the specific lender.

    Holding

    No, because the allegations failed to demonstrate a relationship between the parties sufficiently approaching privity; Westpac was merely one of a class of “potential bridge lenders,” not a specifically known party relying on Seidman’s work.

    Court’s Reasoning

    The court applied the three-prong test established in Credit Alliance Corp. v. Andersen & Co., requiring (1) awareness that the financial reports were to be used for a particular purpose; (2) a known party was intended to rely on the reports; and (3) conduct by the accountants linking them to that party. The court found that while Seidman may have known that the statements were to be used to obtain a bridge loan, Westpac was merely one of a class of potential lenders. There was no evidence that Seidman knew Turnkey was showing the reports to Westpac. The court emphasized that knowledge of a class of potential lenders is not equivalent to knowledge of “the identity of the specific nonprivy party who would be relying upon the audit reports.” The court also noted the absence of any direct dealings between Seidman and Westpac that would create the necessary link between them. The court rejected Westpac’s argument that potential liability under federal securities laws expanded the accountant’s common-law duty, stating that such laws address different policy concerns.

  • Guarente v. J. Harrington Associates, 40 N.Y.2d 330 (1976): Accountant Liability to Known Third Parties

    Guarente v. J. Harrington Associates, 40 N.Y.2d 330 (1976)

    An accountant may be held liable for negligence to a limited class of investors whose reliance on the accountant’s work is specifically foreseen, even without direct privity of contract.

    Summary

    Guarente, a limited partner in J. Harrington Associates, sued the partnership’s accountants, Arthur Andersen & Co., for professional malpractice. Guarente claimed Andersen negligently performed auditing and tax return services, failing to disclose the general partners’ improper withdrawals. The New York Court of Appeals held that Andersen could be liable to the limited partners, a known and finite group who foreseeably relied on Andersen’s work, distinguishing this from the broader liability rejected in Ultramares. This case establishes an exception to the privity requirement in accountant liability cases when the accountant’s services are intended for the benefit of a specific, known group.

    Facts

    Guarente was a limited partner in J. Harrington Associates, a limited partnership. The partnership agreement stipulated that the partnership’s books be audited annually by a certified public accountant. The partnership retained Arthur Andersen & Co. to perform these auditing and tax return services. Guarente alleged that Andersen knew or should have known that the general partners were improperly withdrawing funds in violation of the partnership agreement. He further claimed that Andersen’s audit reports and financial statements were inaccurate and misleading, specifically regarding these withdrawals and the valuation of restricted securities.

    Procedural History

    Guarente moved to amend the complaint, and Andersen moved to dismiss the claim against it for failure to state a cause of action. Special Term dismissed the complaint against Andersen and severed the claim. The Appellate Division affirmed the dismissal. Guarente appealed to the New York Court of Appeals.

    Issue(s)

    Whether accountants retained by a limited partnership to perform auditing and tax return services may be held responsible to an identifiable group of limited partners for negligence in the execution of those professional services, despite the absence of direct privity.

    Holding

    Yes, because the services of the accountant were not extended to a faceless or unresolved class of persons, but rather to a known group possessed of vested rights, marked by a definable limit and made up of certain components.

    Court’s Reasoning

    The Court of Appeals distinguished this case from Ultramares Corp. v. Touche, which held that accountants are not liable to an indeterminate class of persons who might rely on their audits. The court emphasized that in Guarente, the services were rendered for the benefit of a known group of limited partners with vested rights. The court noted that Andersen must have been aware that the limited partners would necessarily rely on the audit and tax returns to prepare their own tax returns. The court stated that “the furnishing of the audit and tax return information, necessarily by virtue of the relation, was one of the ends and aims of the transaction.” The court quoted Hochfelder v Ernst & Ernst, stating: “the courts in diminishing the impact of Ultramares have not only embraced the rule of Glanzer—liability to a foreseen plaintiff—but have extended an accountant’s liability for negligence to those who, although not themselves foreseen, are members of a limited class whose reliance on the financial statements is specifically foreseen.” The court reasoned that because Guarente was a member of a limited class whose reliance on the audit and returns was, or at least should have been, specifically foreseen, a duty of care existed. The court concluded that the accountant’s duty extended to the limited partners despite the lack of direct contractual privity, because “[t]he duty of reasonable care in the performance of a contract is not always owed solely to the person with whom the contract is made…It may inure to the benefit of others”. This case expanded the scope of accountant’s liability beyond strict privity to include specifically foreseen and identifiable third-party beneficiaries, illustrating a practical exception to the general rule established in Ultramares.